Stocks are not passive income in the eyes of the IRS. Dividends and capital gains from stocks you own in a brokerage account fall into a separate tax category called portfolio income, which sits alongside earned income (wages) and passive income (rentals and businesses you don’t actively run) as one of three distinct buckets. The label matters because portfolio income follows its own rules for rates, losses, and offsets, and treating stocks as passive can lead to real mistakes on your return.
What the IRS Means by Passive Income
Passive income has a specific legal definition under Internal Revenue Code Section 469. It covers trade or business activities where you don’t materially participate, plus most rental activities.1Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited Portfolio income is a distinct third category that includes interest, dividends, annuities, and royalties not earned in the ordinary course of a trade or business.2Internal Revenue Service. Publication 550 (2024), Investment Income and Expenses
When people describe stocks as “passive income,” they usually mean money that arrives without clocking in somewhere. That’s the everyday meaning, not the tax meaning. The classification has a real consequence: passive activity losses generally cannot offset portfolio income. If you have a loss from a rental property, you can’t use it to shelter your stock dividends or capital gains. The two categories live in different rooms.
How Stock Dividends Are Taxed
Companies distribute profits as dividends, and the tax treatment turns on whether those dividends are “qualified” or “ordinary.” Qualified dividends are taxed at the same preferential rates as long-term capital gains: 0%, 15%, or 20%, depending on your taxable income.3Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Ordinary dividends that don’t meet the qualified threshold are taxed at your regular income tax rates, which can reach 37% in 2026.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
A dividend qualifies for the lower rate only if you held the underlying stock for more than 60 days during the 121-day window that begins 60 days before the ex-dividend date.5Internal Revenue Service. Instructions for Form 1099-DIV Buy shares just before a dividend and sell them right after, and the payment is taxed as ordinary income at your full rate. Your broker reports which dividends are qualified and which aren’t on Form 1099-DIV, so most investors don’t need to track the window themselves unless they’re trading around dividend dates.
How Capital Gains Are Taxed
When you sell stock for more than you paid, the profit is a capital gain. The rate depends almost entirely on how long you held the shares. Short-term gains, on stock held one year or less, are taxed at the same rates as ordinary income. Long-term gains, on stock held more than one year, get the preferential 0%, 15%, or 20% rates.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses That one-year line is the most important tax variable for stock investors.
Start counting the day after you buy. The day you sell counts as part of your holding period. Buy on June 15, 2025, and you’d need to sell on June 16, 2026 or later for the gain to be long-term. Selling on June 15, 2026 is still short-term by one day.2Internal Revenue Service. Publication 550 (2024), Investment Income and Expenses
2026 Long-Term Capital Gains Brackets
The income thresholds for the three long-term capital gains rates in 2026 are:4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
- 0% rate: taxable income up to $49,450 (single) or $98,900 (married filing jointly)
- 15% rate: taxable income from $49,451 to $545,500 (single) or $98,901 to $613,700 (married filing jointly)
- 20% rate: taxable income above $545,500 (single) or $613,700 (married filing jointly)
The 0% bracket is where a lot of retirees and part-time workers find good news. If your total taxable income, including the gains themselves, stays under the threshold, you owe nothing on long-term stock profits. Someone in the 15% long-term bracket keeps 85 cents of each dollar of gain, compared with 63 cents for a short-term gain taxed at the top 37% ordinary rate.
Capital Losses and the $3,000 Limit
Losses work in your favor, with limits. You first net losses against gains for the year. Short-term losses offset short-term gains first, and long-term losses offset long-term gains first. If total losses exceed total gains, you can deduct up to $3,000 of the excess against other income like wages ($1,500 if married filing separately).6Internal Revenue Service. Topic No. 409, Capital Gains and Losses
Anything beyond that $3,000 carries forward to the next year indefinitely. A $25,000 loss becomes a $3,000 deduction now and a $22,000 carryover. The carryover keeps its short-term or long-term character, and you can use it to offset future gains or claim another $3,000 each year until it’s gone.
The Wash Sale Rule
You can’t sell stock at a loss, buy it right back, and claim the deduction. The wash sale rule disallows the loss if you purchase substantially identical securities within 30 days before or after the sale.2Internal Revenue Service. Publication 550 (2024), Investment Income and Expenses The rule also triggers if your spouse or a corporation you control buys the same stock, or if you acquire the shares in an IRA or Roth IRA during that window. The disallowed loss isn’t erased. It gets added to the cost basis of the replacement shares, deferring the deduction until you eventually sell those shares without triggering another wash sale.
The 3.8% Net Investment Income Tax
Higher earners face an additional 3.8% surtax on net investment income, which includes dividends and capital gains from stocks. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds these thresholds:7Internal Revenue Service. Topic No. 559, Net Investment Income Tax
- Single or head of household: $200,000
- Married filing jointly: $250,000
- Married filing separately: $125,000
These thresholds are not adjusted for inflation, so more taxpayers cross them each year as incomes rise. A single filer earning $240,000 with $50,000 in stock gains would owe the surtax on the lesser of $50,000 or $40,000 (the excess over $200,000), for an extra $1,520 on top of regular capital gains tax. Combined with the 20% top long-term rate, the NIIT brings the maximum federal rate on stock profits to 23.8%.
When the IRS Treats You as a Trader Instead
Almost everyone who owns stocks is an investor for tax purposes, and the portfolio-income rules above apply. A narrow group qualifies as traders in securities, which changes how expenses are handled. To qualify, you must meet all three of these tests:8Internal Revenue Service. Topic No. 429, Traders in Securities
- You seek profits from daily market movements, not from dividends, interest, or long-term appreciation.
- Your trading volume, dollar amounts, and frequency reflect a business-level commitment.
- You trade with continuity and regularity, not sporadically.
Buying index funds twice a year and checking your portfolio every few weeks makes you an investor. Trader status is reserved for activity that resembles a full-time job. Even for traders, gains and losses from selling securities are not subject to self-employment tax, and without a separate mark-to-market election under Section 475(f) they remain capital gains subject to the same $3,000 loss cap and wash sale rule that apply to everyone else.
Stocks Inside Retirement Accounts Are a Different Story
Everything above assumes a taxable brokerage account. Retirement accounts change the picture because the account itself acts as a tax wrapper around whatever sits inside it. In a traditional IRA or traditional 401(k), dividends and capital gains accumulate with no annual tax. You owe nothing when a stock pays a dividend or when you sell shares at a profit inside the account. The trade-off arrives at withdrawal: every dollar you take out in retirement is taxed as ordinary income at your regular rate, and the preferential long-term capital gains and qualified dividend rates don’t apply.9Internal Revenue Service. Roth IRAs
In a Roth IRA or Roth 401(k), you contribute after-tax dollars, but qualified distributions (generally after age 59½ and at least five years after your first contribution) come out completely tax-free, growth included. A stock that doubles inside a Roth owes zero federal tax on the gain if you meet the distribution rules. So while stocks are portfolio income in a brokerage account, they generate no current tax at all inside a retirement account, and the eventual tax depends on which type of account you used.